The Spanish bailout has triggered a big ongoing debate on the issue of seniority for public creditors. Certain commentators and market actors claim that it is because the European Stability Mechanism (ESM) sees itself as a preferred creditor that the announcement of a Spanish bailout has led to rising spreads. They say that seniority means that once the ESM comes in, it reduces the effective claims of the private bondholders in the event of a restructuring.
This piece exposes the flaws in this thinking both in the general case and more particularly in the case of Spain. We conclude that if the EU wants to rescue Spain, the trick is not to remove seniority from the ESM but 1) to remove all uncertainties around the future of the Eurozone 2) make conditionality more growth friendly 3) channel the bailout directly to needy banks without going through the sovereign.